How about paying off your mortgage?
Like really tried, instead of playing make-believe and extending.
Sure, refinance here and there to save interest, but hang in there and relentlessly focus on every penny and all your energy. to hammer this debt.
If you’ve ever wondered what happens to your well-being and net worth when this happens, well, Occidental Petroleum (NYSE: OXY) is about to deliver a case study to you because in the coming months we believe it will radically transform and put it on solid footing for the coming energy shortage.
It starts in Q1
First quarter results were in line with expectations. Apart from a large working capital adjustment caused by some seasonal payments and rapidly rising oil prices (most of which are expected to reverse), quarterly results were just fine. We continue to believe that OXY will generate approximately $13-14 billion in free cash flow using conservative assumptions.
As OXY reduces its debt, it intends to focus its efforts on a $3 billion share buyback that is expected to close in the third quarter. Thereafter, it will revert to repaying long-term debt until gross debt reaches teenagers. Gross debt is $24.9B today, so it should take about two quarters (i.e. ~$6.5B of free cash flow assuming a 13 billion/yr = ~$18.4 billion) to reach the goal, which brings us to early 2023.
At that time, rating agencies should re-assign OXY an investment grade (“IG”) company. This is an important step because by then, between the common stock dividends and the $3 billion share buybacks (which count as “distributions”), OXY will be on the verge of triggering the obligation to repurchase Berkshire (BRK.A) (BRK.B)/Warren Buffett’s preferred stock. Remember that once the distributions to shareholders exceed $4/share, the company must buy back the $10 billion of preferred shares with a premium of 10% (or $11 billion). As expected, we expect OXY to cross the $4/share threshold by Q1 23 (i.e. $0.13/share dividend for 4 quarters + $3 billion buyback of shares, spread over 937 million shares outstanding = ~$3.72/share (no doubt OXY will increase the payout to reach this threshold)).
After which he can start withdrawing the preferred stock which has been an eyesore/overhang for investors given the high cost of capital and the ‘perception’ that this is a cap on the increase returns for shareholders. Thus, the elimination of preferred shares will go a long way towards cleaning up OXY’s balance sheet after the acquisition of Anadarko. So how will OXY go about it? Well, here’s a scenario we might see unfold:
- First, OXY as of March 31, 2022 has 937 million shares outstanding, Buffett owns 143 million, or 15.3%. On the debt side, the company has about $35 billion in debt ($24.9 billion gross debt and $10 billion in preferred stock).
2. Second, after announcing a $3 billion share buyback, OXY will repurchase nearly 47 million shares, or nearly 5% of outstanding shares. This helps the company move toward the $4/share shareholder payout needed to trigger the preferred stock buyback.
3. Third, Buffett will likely offer to trade $5 billion of his $10 billion in preferred stock, to exercise his 83.9 million warrants, re-running his Bank of America playbook. We think OXY would accept such a cashless offer because they would have to issue the shares anyway if he exercised the warrants for cash, they just bought out about half of the shares to be issued with the buyout, that reduces the leverage and improves cash flow.
4. Fourth, Buffett will still hold $5 billion in preferred stock remaining, but once the $4/share distribution target is reached, OXY will begin to redeem the preferred stock. It can do this either via free cash flow, or more likely borrow short-term (using its new IG rating) and essentially refinance preferred stock. Most likely it will use a combination of free cash flow and short-term borrowing (perhaps on a line of credit) depending on oil prices.
5. Finally, we assume that the ordinary warrants issued in 2020 (at the request of Carl Icahn) will eventually be exercised given that their exercise price is $22 and that they are currently well-in-the-money.
So, by the second quarter of 2023, where does all this leave us? Essentially with a company that will have reduced its debt from $35B to ~$16B. The remaining ~$16 billion will continue to decline as free cash flow builds in 2023 and beyond. To put that into perspective, this is currently a company that currently has an enterprise value of approximately $100 billion, split $64 billion in equity and $35 billion in debt. In less than a year, the debt level will drop to $16 billion. Without rerating, the shares should appreciate by $20 billion. While we certainly believe a reassessment will occur, we don’t need it to see the roadmap of where it’s headed.
Given the evolution of oil prices, OXY will be almost debt free by 2024. Alternatively, if the company is happy with the debt levels once the above happens, it can redirect the 13 to 14 billions of annual FCF dollars towards shareholder returns. Either way (and perhaps a mix of the two), this is a stunning turnaround for a company that was on the brink of bankruptcy nearly two years ago. As we wrote before, Vicki was right.
Ultimately, we plan to stay in this house for the long term. Why wouldn’t we?
It’s almost paid off.